1.5 – Currency Futures

Description: This forex course basics section covers the nature of currency futures and how they trade on futures exchanges like the IMM.

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Currency futures have a completely different manner of trading than the cash foreign exchange market where transactions primarily take place in the spot and forward markets over an extensive electronic and telephone network.

The currency futures market was originally developed by the International Monetary Market or IMM division of the Chicago Mercantile Exchange in 1972, which has since been the principal exchange for this derivative product.

Since that time, the currency futures market has achieved outstanding growth. In fact, for many years, trading currency futures on the Chicago Mercantile Exchange was the only way for individual traders to participate in the forex market.

Nevertheless, the size of the forex currency futures market accounts for just 7% of the total daily forex volume of almost 3 trillion dollars per day. This still amounts to just over $200 billion per day in terms of the notional amount of currency futures trading volume.

Definition of a Futures Contract

Currency futures contracts consist of standardized, exchange traded agreements for delivery of one currency against the receipt of another on a fixed date for a price determined in the marketplace.

Basically, a currency futures contract amounts to a forex forward contract with a standard delivery date and with all deals conducted via a centralized exchange.

Key Differences Between Currency Futures and Spot Trades

IMM futures contracts, unlike spot trades which deliver within two business days, generally have quarterly delivery dates which typically occur on the third Wednesday of the month.

For example, British Pound Sterling futures contracts would be deliverable in the months of March, June, September or December. Each GBP futures contract would involve a transaction amount or lot size of 62,500 British Pounds and the counter currency would be the U.S. Dollar.

Furthermore, since the transaction takes place in the United States, the currency pair is traded in U.S. Dollar pricing terms. This means that the exchange rate for currency pairs such as the EUR/USD, AUD/USD, NZD/USD and GBP/USD are quoted the same as in the spot market, while USD/JPY and USD/CAD quotes are inverted.

How Futures Are Traded

As previously mentioned, currency futures began trading on the Chicago Mercantile Exchange in 1972. The exchange was originally for commodities futures, but welcomed the new currency instruments since commodities traders were already familiar with trading futures.

Currency futures trade in a pit through an open outcry system. The action appears to be chaotic, although the frenetic activity is carefully orchestrated for maximum efficiency.

Traders in the currency futures markets often get instant fills and fair prices from both the “locals” — independents trading for their own account — and brokers who are just filling orders for customers.

A commodities futures trading account typically must be opened to trade in the currency futures market, because the regulating body for these contracts is the Commodities Futures Trading Commission.

Forex Trading Versus Currency Futures

Other important differences between the two markets include the amount of leverage permitted. In the futures market, the leverage involves a 20% margin deposit or a leverage factor of 5:1.

Compare this with the much greater leverage possible in some online retail forex accounts which runs as high as 500:1. Such leverage is 100 times larger than the leverage for currency futures.

The other major difference is the standardized size of the currency futures contracts. For example, the GBP contract is for £62,500, while the JPY contract is for ¥12,500.000. This can make transactions of sizes other than the contract lot size or multiples of that amount awkward to execute.

In addition, opening a commodities trading account might have higher capital and credit requirements, and so might not be as easy to open as an online forex account.

Basically, although currency futures were at one time the only way for a smaller trader to participate in the forex market, they did not popularize the forex market with retail traders like the advent of the Internet and online forex trading has.